Insurance Coalition Suggests BEAT Clarification

September 13, 2018

The Honorable Steven Mnuchin
Secretary
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

Mr. Lafayette G. "Chip" Harter III
Deputy Assistant Secretary of the Treasury
International Tax Affairs
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

The Honorable David Kautter
Acting Commissioner of the IRS and Assistant Secretary of the Treasury
1111 Constitution Avenue, NW
Washington, D.C. 20224

Mr. William Paul
Acting Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

Re: Section 59A Regulatory Guidance

Dear Sirs:

On behalf of the members of our coalition,¹ we want to thank you for the time you and your colleagues have spent meeting with us and other taxpayers considering the application of the Base Erosion Anti-Abuse Tax (BEAT), particularly with respect to the use of “foreign affiliate reinsurance.” As we have discussed, the members of our coalition believe the BEAT is working largely as intended to address the foreign affiliate reinsurance loophole, and has not adversely affected capacity or pricing in the insurance market as the availability of capital remains strong.²

Prior to passage of the BEAT, foreign-owned insurance companies were using affiliate reinsurance to strip much of their U.S. profits to low tax/no tax countries like Bermuda and Switzerland to avoid U.S. taxes that U.S.-based companies were required to pay. This tax break provided foreign-owned companies with an unfair competitive advantage over American companies in doing business here at home and resulted in foreign companies gaining domestic market share at the expense of American-owned companies. Several companies inverted overseas to take advantage of this loophole.

Fortunately, policymakers recognized the need to address this unintended loophole as part of H.R. 1 by adopting the BEAT. According to the legislative history, the BEAT was created to function as a minimum tax in order to preclude companies from eroding the tax base through use of certain related-party payments. For this purpose, Congress singled out reinsurance payments to foreign affiliates as a type of base erosion payment subject to the BEAT.

The adoption of BEAT has helped to level the competitive playing field. As Dowling & Partners, a leading insurance industry expert, has said, “U.S. based primary insurers will no longer operate with the significant economic/mathematical/structural disadvantages relative to foreign based entities. All else equal, and they never are, the lower U.S. corporate tax rate, when combined with the effective elimination of the ability to undertake tax advantaged quota-share agreements with "affiliated" entities, brings U.S. primary insurers to at least parity with foreign owned insurers.”³

We are already seeing positive economic impacts in the insurance industry. The pressure to invert and the capital flight to offshore domiciles have diminished significantly as a result of the BEAT and other changes that were made. For example, Assurant reversed its plans to invert into The Warranty Group and instead acquired the Bermuda-based company and remained in the U.S. Several foreign companies also have announced they are unwinding their large intercompany quota share arrangements, keeping their insurance business and reserves (and the associated U.S. taxes) in the United States. Finally, in announcing U.S.-based AIG's plans to acquire Bermuda-based reinsurer Validus, the Financial Times commented that “Along with a lower US headline corporate rate, the BEAT diminishes whatever advantages Bermuda-based reinsurers had in writing business. It is no surprise that groups, which tried to engage in Bermuda tax arbitrage, are now seeking rescues by the likes of AIG. Bermuda's airport may be welcoming many more US CEOs in the months ahead.”⁴

Application of BEAT

The BEAT has a broader base (but lower rate) than the regular tax and only applies if it exceeds the taxpayer's regular tax liability after reduction for tax credits (other than certain specified credits in years prior to 2026). The tax base for the BEAT is the taxpayer's regular taxable income, plus (1) any “base erosion tax benefits” arising from specified base erosion payments and (2) the “base erosion percentage” amount of any net operating loss (NOL) deduction allowable for the tax year. For the purpose of the BEAT, a base erosion payment specifically includes any premium or other consideration for reinsurance paid or accrued to a foreign related party. The BEAT rate is five percent for tax years beginning in calendar year 2018, 10 percent for tax years beginning in 2019 through 2025, and 12.5 percent for tax years beginning after December 31, 2025.

Thus, assuming a 10% BEAT rate and not taking into account any applicable credits or exceptions,⁵ the BEAT generally will apply only if any affiliate reinsurance (and other base erosion) payments are close to or exceed 100% of the U.S. taxpayer's regular taxable income. Thus, the BEAT still permits a significant amount of foreign affiliate reinsurance and only applies to “excessive” payments.

Keep the Reinsurance Loophole Closed

We are concerned that a few comment letters to Treasury regarding the BEAT seek indirectly to reopen the loophole and threaten to eviscerate the progress that has been made to date.

For example, in a letter regarding Modco cessions,⁶ the commenters suggest that the base erosion tax benefit would be better measured by the reinsurance settlement payment made to the related foreign reinsurer rather than the reinsurance premium paid, and investment income ceded, to the foreign affiliate. We believe, however, that such treatment (i.e., effective netting) is clearly inappropriate under the language of the BEAT and would result in substantively equivalent transactions being treated very differently.

Modco is economically identical to coinsurance, and the income statement effects are the same. According to the Society of Actuaries, the emphasis should be on "coinsurance” and not on "modified," because “all of the specifics of Coinsurance apply to Modco.”⁷ The only difference is who holds the reserves (and the investment assets with respect to the reserves) and the attendant accounting to reflect reserve credits/adjustments. In Modco arrangements, the ceding company retains the reserves and the investment assets.

Ceded premium paid under coinsurance is a reduction in premium income and is clearly treated as a base erosion payment if paid to a related foreign reinsurer. Similarly, for both tax and regulatory accounting purposes, Modco premium ceded is treated as a reduction in premium income. The amount returned to the ceding company as a prepayment of future obligations under the reinsurance contract is recorded for regulatory purposes as “reserve adjustments on reinsurance ceded,” an item separate from premium income (not return premium). Interest income on the invested assets is credited to the reinsurer in this same “reserve adjustments on reinsurance ceded” account. Thus, any premiums paid or accrued to a related foreign insurer in a Modco arrangement should be treated as base erosion payments, rather than only the net reinsurance settlement payment as suggested by the commenters. Allowance of effective netting as suggested by the commenters would treat economically similar transactions differently, create an incentive to prefer Modco to standard coinsurance, and effectively reopen the affiliate reinsurance loophole which was addressed by the BEAT.

Thus, we respectfully request that Treasury clarify that the BEAT applies to the reduction in premium income for ceded premium under Modco contracts with no netting of Modco reserve adjustments or other returns. Section 803(a)(1)(B) includes reductions in premium income for modified coinsurance premium ceded (regardless of subsequent return Modco reserve adjustments). Moreover, any subsequent Modco adjustment should be broken into its components rather than netted. The gross amount payable to the foreign related reinsurer as premium or investment income should be subject to the BEAT. This is the appropriate treatment under the statute and is necessary to maintain parity between Modco and coinsurance transactions.

For similar reasons, we are concerned about a recent submission sent to Treasury from Chubb.⁸ In the e-mail, they suggest that “losses incurred” on reinsurance assumed into the U.S. from a foreign affiliate should not be base erosion payments. While we agree with the general premise that losses incurred should not be treated as base erosion payments, their proposed regulatory fix — to carve out from BEAT any reductions from gross income in section 803 or 832(b)(1) (other than reinsurance premium payments) — is far broader in application. First, their proposed solution may be interpreted to allow Modco reserve adjustments to be netted against reinsurance premium and investment income payments to foreign related parties in applying the BEAT. For the reasons described above with respect to the first comment letter, we believe this is inappropriate under the terms of the statute, would treat similar transactions very differently, and would reopen the reinsurance loophole through use of Modco arrangements.

Second, in the case of properly & casualty insurance, their proposed solution carving out amounts covered by section 832(b)(1) has the potential to exclude from BEAT several forms of base erosion payments made to affiliates such as interest, rents and service payments. This would allow them effectively to skirt the BEAT, and reopen the loophole by restructuring their offshore arrangements to include greater services and interest rather than reinsurance premiums, or to include other payments made by noninsurance companies in the reinsurance contract. It is important to note that each of these items is treated as a deduction both for annual statement purposes and under section 832(c). Also, they are clearly the types of base erosion payments that Congress intended to subject to the BEAT.

Thus, because the adoption of BEAT was clearly intended to discourage base erosion, we respectfully request that Treasury and the IRS ensure that any regulatory interpretations regarding application of the BEAT with respect to the insurance industry do not allow or promote base erosion. In fact, we encourage Treasury to use its authority to prevent avoidance of BEAT by identifying transactions or arrangements that are designed, in whole or in part, to characterize payments otherwise subject to BEAT as payments not subject to BEAT (Section 59A(i)(1)(B)(i)).⁹

By contrast, as suggested in a recent comment letter from AIG,¹⁰ we believe that Treasury and the IRS should clarify that losses incurred and claims or benefit payments under a reinsurance contract between a U.S. reinsurer and a foreign related party are not treated as base erosion payments. The payment of claims is an integral part of reinsurance transactions that help to grow the U.S. tax base by bringing premiums, investment income and profits to the U.S, and thus help enlarge (rather than erode) the U.S. tax base. Also, these payments are not effectively related party payments as they ultimately go to third party customers, and the group as a whole does not control the timing or amount of such payments. Therefore, we believe it would be consistent with the legislative intent of the BEAT to clarify that any such loss, claims, or benefit payments on reinsurance provided to a foreign related party are not subject to the BEAT.¹¹

However, the appropriate treatment of ceding commissions paid to foreign related parties is less clear. While such payments are also with respect to transactions that grow the U.S. tax base, ceding commissions themselves are comprised of many types of expenses and often include a profit or contingent profit. While the AIG example is simple, ceding commissions are often ill-defined or identified as a percentage of premium. This leads to variability across contracts and allows for flexibility, particularly in the related party context. To avoid incentives for base erosion in the insurance industry, any guidance with respect to ceding commissions should be consistent with the treatment provided to similar services or other costs in other similar arrangements and industries.

Once again, we greatly appreciate the opportunity to provide our comments and suggestions for your consideration in connection with the proposed guidance regarding the BEAT. Please let us know if you have any questions or comments. We would be glad to meet with you to discuss these issues further.

Sincerely yours,

Jo-Marie St. Martin
On behalf of the Coalition for American Insurance
Vice President, Federal Government Relations
W.R. Berkley Corporation

cc:
Douglas Poms
Brian Jenn
Brett York
Kevin Nichols
David Brazell
Marjorie Rollinson
Daniel McCall